Accounting is the process of recording business transactions and using the records to create financial statements.
Every transaction is posted to the accounting records using a journal entry, which is a document that collects all of the important data for a particular transaction.
A business owner must understand what a journal entry is, and how to post entries. Even if an accountant posts all of your firm’s journal entries for you, you should be able to review the entries and understand them so you can make informed decisions about them later.
A journal entry is entered into a journal, which accountants refer to as the “books of original entry. That definition makes sense, because a journal is the first place a transaction is recorded in the accounting records. Accountants use the phrase “posting a journal entry” or “journalizing an entry” when referring to the journal entry process.
Let’s assume that a furniture maker pays $1,000 to purchase maple wood to make chairs, and that the company accountant posts the journal entry on June 30th, 2018. Here’s how a journal entry is formatted:
|June 30||Wood Material||#5000||$1,000|
|Cash (To purchase maple wood material for cash)||#1000||$1,000|
As a business owner, you need to understand each component of a journal entry. Keep in mind that, in may cases, either the company accountant or the owner must search the accounting records (typically using accounting software) to find a particular transaction. For that reason, it’s important to input all of the information you see here, in order to find the right transaction down the road.
- Date: Post the month, day, and year. In order for accounting information to be accurate, it needs to be posted to the correct month and year.
- Account: Every business uses a chart of accounts, which is a list of each account used in the accounting system, and the corresponding account number. When you purchase accounting software, your system will provide a standard chart of accounts that you can change over time. Wood material is an inventory account, which is an asset, and cash is also an asset account. Account numbers are also listed here.
- Debits and credits: Accounting entries are posted using debits and credits. Debits are always posted on the left, and credits on the right. Asset accounts are increased with a debit entry. Since this journal entry affects two asset accounts, wood material (inventory) is increased by debiting $1,000, and cash is reduced with the $1,000 credit. Every journal entry includes at least one debit and one credit, and the total dollar amount of debits and credits must be equal.
- Description: This is perhaps the most important data in your journal entry, because it explains why the entry was posted. A business may have hundreds or even thousands of journal entries a month, and the description is a big help when trying to find a particular transaction. If you were only looking at wood material activity, you would see the description on the listing dated June 30th. The same is true of cash, because the description would be listed among the cash activity on June 30th. You can add helpful information to the description, such as an invoice number, purchase order number, or the name of a vendor.
Once all of the journal entries are posted for a particular month, the accountant generates a trial balance, which is a listing of every account and its month-end balance. After posting adjustments, the adjusted trial balance is used to produce the financial statements.